The Estate, Gift & Trust section is a compilation of alerts and articles written by members of the ICPAS Estate, Gift & Trust Committee as well as links to websites and other resources of interest to the estate, gift & trust community. Follow the links below for more information on these topics.

Estate, Gift & Trust Committee Articles

What is an Intentionally Defective Grantor Trust (“IDGT”)?
A grantor trust is a trust that is subject to the Internal Revenue Code (“IRC”) Sections 671-679 known as the “grantor trust rules”. The grantor of the trust is treated as the owner of the trust property and includes the trust’s income, deductions, and credits as their own in computing taxable income. There are two types of grantor trusts: revocable and irrevocable. The revocable trust is a common trust someone might set up in order to avoid probate court upon death or for asset protection from creditors. An irrevocable trust that is purposefully drafted with certain grantor trust provisions is an intentionally defective grantor trust. Despite the negative connotation of the word ‘defective’, this is in fact an intentional drafting to invoke the grantor trust rules for a variety of long-term estate planning purposes.

What are the Consequences of Funding an IDGT?Estate Tax
Upon transferring assets to an IDGT, the funding is deemed to have been a “completed” transfer out of the grantor’s estate for estate tax purposes. This means that the property put into the intentionally defective trust will not be subject to estate tax inclusion upon the grantor’s death. Additionally, any growth on the assets after the trust has been funded will accumulate without increasing the grantor’s estate.

Gift Tax
Under all transfer tax systems, the funding of an IDGT is deemed to be a completed gift and therefore is considered a lifetime gift subject to the gift tax. However, taxpayers have a basic exclusion amount that they can gift before the gift would be subject to gift tax. Under the new law H.R. 1, originally called the Tax Cuts and Jobs Act, the basic exclusion amount effectively doubled. The new law states that the exclusion amount is $10 million before taking into account inflation adjustments, resulting in a $11.18 million exclusion. Due to this temporary increase, until December 31, 2025, now is a good time for taxpayers to reevaluate their estate plans and to consider using techniques such as an IDGT.

Generation Skipping Transfer (“GST”) Tax
If the IDGT has a “skip person” as a beneficiary, the transfer of assets to the trust by the grantor would be subject to a GST tax. A skip person is someone more than one generation younger than the grantor; for example, grandparent gift to grandchild. However, similar to the gift tax, a taxpayer may use their GST tax exemption to transfer the trust property and allow the growth to continue within the trust tax free. Under the new law, a taxpayer’s GST tax exemption has increased to $11.18 million.

Income Tax
Contrary to the three aforementioned transfer tax systems, funding an IDGT is an “incomplete” transfer for income tax purposes and therefore all income, deductions, and credits from the trust are reported on the grantor’s annual income tax return. Due to the fact that a trust reaches the highest income tax bracket at a much lower threshold than an individual, there is a potential for income tax savings. Additionally, the grantor paying the income tax is also lowering the ultimate estate value of the grantor without the payment of the income tax being constituted as an additional gift (Revenue Ruling 2004-64). However, the grantor should ensure they have the funds to pay the income tax liability resulting from the IDGT. The grantor is responsible for the tax liability even though they are not entitled to any distributions from the trust. If the grantor is married, the spouse could be made a beneficiary of the trust and therefore eligible to receive distributions.

Sale of Assets to an IDGT
The sale of highly appreciating assets to an IDGT is a powerful estate freeze technique. For income tax purposes a taxpayer cannot sell something to himself and therefore a sale of an asset to a grantor trust is disregarded (Revenue Ruling 85-13). A sale of assets from the grantor to an IDGT results in no capital gains being recognized. Additionally, the trust receives carryover basis with respect to the assets received in the sale. The sale could be structured as an installment sale with a promissory note. It is commonplace for the grantor to make a “seed” gift of at least 10% of the anticipated purchase price into the IDGT as a separate gift so that the sale transaction is respected by the IRS. Should the grantor die before the completion of the note there could be additional estate and income tax consequences since the subsequent payments would not be the grantor paying it to himself anymore.

The Internal Revenue Service recently announced the 2018 Inflation Adjustments in Revenue Procedure 2017-58. By law, the dollar amounts for a variety of tax provisions are required to be revised each year to keep up with inflation. The result of this is that certain tax benefits are subject to inflation adjustments each year. However, since recent inflation factors have been minimal, many of these benefits will stay the same or change only slightly for 2018. Key provisions affecting 2018 estate, gift, and trust returns, filed by most taxpayers in early 2019, include the following:

• ADJUSTED - Estate and Trust Tax Rate Tables - for taxable years beginning in 2018 the 15% rate applies to income not over $2,600 and the maximum 39.6% rate applies to income over $12,700 with graduated rates in between.

• ADJUSTED - Valuation of Qualified Real Property in Decedent's Gross Estate - for an estate of a decedent dying in calendar year 2018, if the executor elects to use the special use valuation method under § 2032A for qualified real property, the aggregate decrease in the value of qualified real property resulting from electing to use § 2032A for purposes of the estate tax cannot exceed $1,140,000. The 2017 amount was $1,120,000.

• ADJUSTED - Unified Credit Against Estate Tax - for an estate of any decedent dying during calendar year 2018, the basic exclusion amount is $5,600,000 for determining the amount of the unified credit against estate tax under § 2010. The 2017 amount was $5,490,000.

• ADJUSTED – Annual gift exclusion - for calendar year 2018, the first $15,000 of gifts to any person (other than gifts of future interests in property) are not included in the total amount of taxable gifts under § 2503 made during that year. The 2017 amount was $14,000.

• ADJUSTED – Annual gift exclusion for gifts to a spouse who is not a US Citizen - for calendar year 2018, the first $152,000 of gifts to a spouse who is not a citizen of the United States (other than gifts of future interests in property) are not included in the total amount of taxable gifts under § 2503 and § 2523(i)(2) made during that year. The 2017 amount was $149,000.

• ADJUSTED - Notice of Large Gifts Received from Foreign Persons - for taxable years beginning in 2018, recipients of gifts from certain foreign persons may be required to report these gifts under § 6039F if the aggregate value of gifts received in a taxable year exceeds $16,111. The 2017 amount was $15,797.

• ADJUSTED - Interest on a Certain Portion of the Estate Tax Payable in Installments - for an estate of a decedent dying in calendar year 2018, the dollar amount used to determine the "2-percent portion" (for purposes of calculating interest under § 6601(j)) is $1,520,000. The 2017 amount was $1,490,000.

• ADJUSTED - Net Investment Income Tax - for taxable years beginning in 2018, if a trust has undistributed Net Investment Income and also has adjusted gross income over $12,700 the investment income will be subject to the 3.8% Net Investment Income Tax. The 2017 adjusted gross income amount was $12,500.

Treasury offered three central justifications for the proposed regulations: (1) reinvigorate the legislative intent of Chapter 13, which, in the view of Treasury, has been maligned by case law and various state law changes; (2) align the regulations with case law ; and (3) informally, Treasury asserted new regulations were justified by the current estate tax exemption levels of $5 million (indexed for inflation – for 2018 $5,600,000).

The proposed regulations focused on two issues: (1) valuation discounts; and (2) family attribution. The proposed regulations, as drafted, would have effectively eliminated valuation discounts associated with closely-held business interests.

Example #1: Partnership A has an enterprise value of $1,000. While a 1% interest would be worth $10 on an enterprise value basis. Valuation principal tell us that the purchaser of a 1% interest would not pay $10 for the interest. A purchaser would not pay more than $6 (or $7) for the interest – reflecting a minority and marketability discount.

Example 1a: Same as Example #1, under the proposed regulations the 1% interest would be valued at $10 for gift and estate tax purposes, despite the fact that no one could sell the interest for that amount.

The proposed regulations also attempted to create a complicated set of technical regulations related to ownership attribution for gift and estate tax purposes.

Response to the proposed regulations was swift and severe from both the courts and estate planning community. In an unrelated case, a Federal District Court flatly rejected the “reinvigoration” theory. Comments from the estate planning community were equally harsh. Through more than 10,000 comments, commentators and practitioners argued that the proposed regulations (1) were inconsistent with the original legislative intent; would result in estate and gift tax valuations higher than economic reality; and (3) would significantly disrupt to orderly transfer of closely held businesses between family members.

After considering comments to the proposed regulations and other legislative reviews order by the Trump Administration, Treasury withdrew the proposed regulations on October 20, 2017. This means that the regulation project is terminated. To restart the process, Treasury would have to publish new proposed regulations and begin the notice and comment process anew.
In addition, when the proposed regulations were issued, practitioners pointed out through several articles that a disclosure referencing the proposed regulations would be required on 2016 gift tax returns to meet the gift tax statute of limitation adequate disclosure standards. With the proposed regulations formally withdrawn, the disclosure is no longer required.

Future Planning ---

While Treasury has withdrawn its attempt to address the valuation issues through new regulations, this is by no means an indication that Treasury position regarding valuation discounts has changed. Its other two options are legislation and court challenges.

In the current legislative environment, gift and estate tax legislation seems to most to be unlikely, which leaves court challenges. It seem likely that Treasury will look to find cases in which it can argue the positions outlined in the proposed regulations.

As practitioners we need to remain mindful and vigilant of these realities. First, the withdrawal of the proposed regulations is neither a reason to accelerate or delay estate planning. As we have advocated since the proposed regulations were issued, business owners and families should continue focusing estate planning on orderly planning steps that are appropriate for the family and the business.

A caveat we would now add to that approach is that Treasury is likely to take a more aggressive posture toward reviewing and challenging the structuring and administration of estate planning techniques. It is important to carefully and completely document the structuring of estate planning techniques. It is equally important to diligently document the implementation and administration of the techniques.

[1] The case law cited dated back more than 25 years and predated the original Section 2704 legislation. As was pointed out in several comments to the proposed regulations, it was a fanciful theory for Treasury to argue that those cases were not considered when the existing Code was passed and corresponding regulations promulgated.

On June 9, 2017, the IRS issued Revenue Procedure 2017-34 which provides a simplified method to obtain an extension of time under Reg. Sec. 301.9100-3 to file a federal estate tax return in order to elect portability. This Revenue Procedure applies to estates that are not otherwise required to file an estate tax return because the value of the sum of the gross estate and adjusted taxable gifts is under the filing threshold which is currently $5,490,000. The Revenue Procedure will be included in Internal Revenue Bulletin 2017-26 dated June 26, 2017.

This simplified method of obtaining an extension in order to elect portability is to be used in lieu of letter rulings that the Service became inundated with regarding estates that failed to meet earlier published extension thresholds. There are no user fees required with respect to this simplified method.

In order to elect portability under Section 2010(c)(5)(A), an estate had to make such an election on a timely filed estate tax return (Form 706) which included a computation of the deceased spouse’s unused exemption (“DSUE”). The estate tax return had to be timely filed including extensions.

Section 301.9100-3 provides standards that the Service is to apply in order to determine whether to grant an extension of time to make an election whose due date is prescribed by regulation or administrative guidance, but not by statute. Note that the due date for obtaining a portability election is found in Reg. Section 20.2010-2(a) and not by statute.

In general, Section 301.9100-3 states that relief will be granted if the taxpayer had established to the satisfaction of the Commissioner that the taxpayer acted reasonably and in good faith and that the granting of the relief would not prejudice the interest of the government. On February 10, 2014, the Service published Rev. Proc. 2014-18 which provided a simplified method for obtaining an extension under Sec. 301.9100-3 to make a portability election in some circumstances where the estate didn’t have to file a federal estate tax return because the value of the assets includable in the estate were less than the filing threshold. However, this relief was available only on or before December 31, 2014. Since December 31, 2014, the Service has issued a number of letter rulings granting an extension where estate tax returns were either not filed or filed late. The large number of those rulings placed a burden on the Service which is one of the reasons why the Service has now issued Rev. Proc. 2017-34.

Rev. Proc. 2017-34 provides a simplified method to obtain an extension of time to elect portability that once again is available to estates having no other filing requirements. This simplified relief is available for a period which ends on the later of January 2, 2018 or the second anniversary of the decedent’s death. Should estates not meet any of these requirements, estates can still file a letter ruling request with the Service.

This simplified method is available under the following circumstances:

The decedent was survived by a spouse.

The decedent died after December 31, 2010.

The decedent is a citizen or resident of the U.S. on the date of death.

The executor is not required to file an estate tax return based on the value of the gross estate plus adjusted taxable gifts.

No estate tax return was filed within the time required.

In order to obtain relief under Revenue Procedure 2017-34, an executor or other representative has to file a complete estate tax return on or before the later of January 2, 2018 or the second anniversary of the decedent’s death. The executor must list at the top of the return “FILE PURSUANT TO REV. PROC. 2017-34 TO ELECT PORTABILITY UNDER SECTION 2010(c)(5)(A).”

This Rev. Proc. will clearly have the desired result of allowing estates to elect portability in cases where personal representatives (or their counsel) were unaware of past deadlines.

In The Estate of Esther M. Hake, D.C., Pa. the two executors sued the United States in order to abate and have reimbursed a penalty that was assessed against their late mother’s estate after the estate tax return was filed late. The executors’ alleged that they were advised by their tax attorney that at the time of filing the tax return extension, the filing and payment deadline had been extended for one year (when in fact, the extension to file was only for 6 months). This fact was not disputed by either party. The executors filed the return on the date they were “told” it was due which was actually 6 months late. The late filing resulted in an assessment of $197,868.26 in late filing penalties and $17,202.44 in interest. After exhausting any administrative remedy with the IRS, the executor’s filed a complaint in the United States District Court, for the Middle District of Pennsylvania.

In the District Court’s Memorandum of Opinion, (Civil No. 1:15-CV-1382), the question at hand is “When an executor relies upon inaccurate advice from legal and tax counsel regarding the extended deadline for filing an estate tax return, in a factual context where determination of filing and payment deadlines are governed by a series of mandatory and discretionary rules which may vary depending upon the residence status of the taxpayer, does that reliance upon professional advice constitute reasonable cause to avoid the assessment of late filing penalties and interest?” The Supreme Court states that reasonable cause will excuse a failure to file timely only “if the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time.” 26 C.F.R.§301.6651-1(c) (1).

The Tax Court has held that there may be reasonable cause when a taxpayer files a return after the due date, relying upon an expert’s incorrect advice. See Estate of La Meres v. Commissioner, 98 T.C. 294, 318 (1992) (“[T]he Tax Court has consistently held that erroneous legal advice with respect to the date on which a return must be filed can constitute reasonable cause for failure to file timely a return if such reliance was reasonable under the circumstances.”)

In the case at hand, it was determined that the executors’ relied upon the advice of their legal counsel and exercised ordinary business care and prudence. Their reliance on this advice was reasonable and therefore, the executor’s motion for summary judgment was granted.

Disclaimer: This article is designed to provide information in regard to the subject matter and has been prepared with the understanding that neither the Illinois CPA Society nor the author of this article is providing accounting, tax or legal advice or is performing any legal, accounting or other professional service. If accounting, tax or legal advice or other expert assistance is required, the services of a competent professional person should be sought.

Key Highlight: On December, 1, 2016, Department of Treasury held a hearing on the proposed regulations under Code Section 2704. Commentators were generally extremely critical of the regulations and requested clarification regarding several points. Department of Treasury acknowledge the proposed regulations require clarifications and that the revision process will likely take a number of months.

In the meantime, the regulations will continue in proposed status. Practitioners are cautioned that, although the proposed regulations are not applicable to 2016 transfers, 2016 Gift Tax returns reporting transfers after the proposed regulations were issued must address the proposed regulations to qualify for statute of limitation protection under the adequate disclosure rules.

Disclaimer: This article is designed to provide information in regard to the subject matter and has been prepared with the understanding that neither the Illinois CPA Society nor the author of this article is providing accounting, tax or legal advice or is performing any legal, accounting or other professional service. If accounting, tax or legal advice or other expert assistance is required, the services of a competent professional person should be sought.

Key Highlight: Various tax benefits will stay the same or change only slightly in 2017 due to inflation, the IRS announced.

The Internal Revenue Service recently announced the 2017 Inflation Adjustments in Revenue Procedure 2016-55. By law, the dollar amounts for a variety of tax provisions are required to be revised each year to keep up with inflation. The result of this is that certain tax benefits are subject to inflation adjustments each year. However, since recent inflation factors have been minimal, many of these benefits will stay the same or change only slightly for 2017. Key provisions affecting 2017 estate, gift, and trust returns, filed by most taxpayers in early 2018, include the following:

• ADJUSTED - Estate and Trust Tax Rate Tables - for taxable years beginning in 2017 the 15% rate applies to income not over $2,550 and the maximum 39.6% rate applies to income over $12,500 with graduated rates in between.
• ADJUSTED - Valuation of Qualified Real Property in Decedent's Gross Estate - for an estate of a decedent dying in calendar year 2017, if the executor elects to use the special use valuation method under § 2032A for qualified real property, the aggregate decrease in the value of qualified real property resulting from electing to use § 2032A for purposes of the estate tax cannot exceed $1,120,000. The 2016 amount was $1,110,000.
• ADJUSTED - Unified Credit Against Estate Tax - for an estate of any decedent dying during calendar year 2017, the basic exclusion amount is $5,490,000 for determining the amount of the unified credit against estate tax under § 2010. The 2016 amount was $5,450,000.
• UNADJUSTED – Annual gift exclusion - for calendar year 2017, the first $14,000 of gifts to any person (other than gifts of future interests in property) are not included in the total amount of taxable gifts under § 2503 made during that year.
• ADJUSTED – Annual gift exclusion for gifts to a spouse who is not a US Citizen - for calendar year 2017, the first $149,000 of gifts to a spouse who is not a citizen of the United States (other than gifts of future interests in property) are not included in the total amount of taxable gifts under § 2503 and § 2523(i)(2) made during that year. The 2016 amount was $148,000.
• ADJUSTED - Notice of Large Gifts Received from Foreign Persons - for taxable years beginning in 2017, recipients of gifts from certain foreign persons may be required to report these gifts under § 6039F if the aggregate value of gifts received in a taxable year exceeds $15,797. The 2016 amount was $15,671.
• ADJUSTED - Interest on a Certain Portion of the Estate Tax Payable in Installments - for an estate of a decedent dying in calendar year 2017, the dollar amount used to determine the "2-percent portion" (for purposes of calculating interest under § 6601(j) of the estate tax extended as provided in § 6166) is $1,490,000. The 2016 amount was $1,480,000.
• ADJUSTED - Net Investment Income Tax - for taxable years beginning in 2017, if a trust has undistributed Net Investment Income and also has adjusted gross income over $12,500 the investment income will be subject to the 3.8% Net Investment Income Tax. The 2016 adjusted gross income amount was $12,400.

Disclaimer: This article is designed to provide information in regard to the subject matter and has been prepared with the understanding that neither the Illinois CPA Society nor the author of this article is providing accounting, tax or legal advice or is performing any legal, accounting or other professional service. If accounting, tax or legal advice or other expert assistance is required, the services of a competent professional person should be sought.

The Department of the Treasury has issued proposed regulations under Section 2704 [REG-163113-02]. The proposed changes could all but eliminate most of the valuation discounts available for transfers of interests in family owned entities when valued for estate, gift, and generation-skipping transfer tax purposes.

Written comments on the proposed regulations are due 90 days from publication in the Federal Register (August 4, 2016). A public hearing is scheduled for December 1, 2016.

Disclaimer: This article is designed to provide information in regard to the subject matter and has been prepared with the understanding that neither the Illinois CPA Society nor the author of this article is providing accounting, tax or legal advice or is performing any legal, accounting or other professional service. If accounting, tax or legal advice or other expert assistance is required, the services of a competent professional person should be sought.

September 26, 2014
David J. Lynam
Lynam & Associates
firm@lynamlaw.com
Key Highlight: The Supreme Court’s ruling only applies to federal bankruptcy law. Inherited IRAs may still be protected under state bankruptcy exemptions. In fact, a recent motion filed in Illinois asserts just that and claims the state exemptions are broader and include inherited IRAs.

The United States Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“the Act”), signed into law by President G.W. Bush, drastically altered the debtor/creditor landscape. It also explicitly extended the bankruptcy protection afforded to qualified retirement plans (401k, 403b) to Individual Retirement Accounts (“IRAs”) up to $1 million, inflation adjusted. (Bankruptcy Code Section 522 (b)). Left to be determined by the changes wrought by the Act was the exemption status of “inherited IRAs,” which are either traditional or Roth IRAs held by inheritors following the death of the IRA owner. There are two categories of IRA inheritors, or beneficiaries, each with distinct inherited IRA tax and distribution requirements- (1) the surviving spouse, and (2) any other beneficiary, including, but not limited to children, grandchildren, estates, and trusts.

On June 12, 2014, the Supreme Court, in Clark v. Rameker, 134 S.Ct. 2242 (2014), ruled in an case from the Bankruptcy Court for the Western District of Wisconsin that despite the Act’s exemption of traditional IRAs up to $1 million, inherited IRAs enjoy no special protection in bankruptcy, and are not exempt from creditor claims in a bankruptcy proceeding under federal law, as the funds they hold do not constitute “retirement funds” within the meaning of the Act. With Americans keeping an estimated $5.4 trillion of assets in IRAs, this decision has far reaching effects on the owners of IRAs. Many who have inherited these retirement benefits hold them in an inherited IRA form to stretch out the required distributions over their life expectancies. This structure is now subject to creditor claims in the event of the beneficiary’s bankruptcy, and also in non bankruptcy state law proceedings, depending on the residence of the beneficiary and that jurisdiction’s particular exemptions.

Instrumental to the Supreme Court’s decision in Clark was the interpretation of the federal bankruptcy exemption of “retirement funds”, with the Court drawing the distinction between inherited IRAs and traditional or Roth IRAs. The Court reasoned that, unlike a regular IRA owner, beneficiaries of an inherited IRA (1) cannot add money to the account, (2) must take out annual distributions under a life expectancy calculation or a fixed five year method (see Internal Revenue Code sections 72(q) (1) and 401(a) (9) (B)), and (3) have the ability to withdraw the totality of the funds at any time without being subject to the early withdrawal penalty. The Court found that these characteristics of an inherited IRA cause it to be more of a ‘pot of money’ rather than a retirement fund, and therefore held the inherited IRA not to be exempt from creditors.

Spousal beneficiaries are entitled to “roll over” or transfer their share of an inherited IRA into their own spousal IRA account. Once rolled over, the funds would not be subject to the claims of spousal creditors under bankruptcy law, based on the rationale utilized by the Supreme Court in Clark. With a spousal IRA, the spouse can make contributions to the spousal IRA, the spouse must take minimum distributions exactly in the same manner as would be true for that particular type of plan, and the 10% early withdrawal penalty applies to the funds rolled over in the event that the spouse withdraws funds before 59½. Generally, if the ability to make penalty free withdrawals for a 59 ½ or younger spouse out of an inherited IRA are trumped by asset protection concerns, this spousal rollover should be performed as soon as practicable in order to obtain the asset protection of the spousal IRA.

For non-spousal beneficiaries holding inherited IRA’s, the states in which they reside have the power to opt out of the federal exemptions listed in section 522(d) of the Bankruptcy Code and either mandate that a debtor select the state exemptions, or allow him to choose between state and federal exemptions. Several states have expressly exempted inherited IRAs from bankruptcy proceedings, although inherited IRA’s may still be subject to creditors in non-bankruptcy state court proceedings in those states.

Illinois requires bankruptcy debtors with IRAs to use state law exemptions covering “retirement plans, including an individual retirement annuity or account” 735 ILCS 5/12-1006(a). Presently, there is little authority on whether this exemption includes inherited IRAs in a bankruptcy proceeding or in non-bankruptcy proceedings under state law. Litigation is now pending in the United States Bankruptcy Court for the Northern District of Illinois (In re Taylor, No. 12-16471 (Bankr. N.D. Ill.)) where a debtor is seeking an exemption for an inherited IRA under 735 ILCS 5/12-1006(a), arguing that the plain language of the applicable Illinois exemption is broader than that of the federal exemption circumscribed by the Supreme Court in Clark.

Owners of IRAs wishing to plan for protection of the beneficiaries of their IRAs from creditors can create a so called “see through” inter vivos or testamentary trust as the IRA’s beneficiary, pursuant to Regulations Section 1.401 (a)(9)-4. If valid under state law, irrevocable at death, individual beneficiaries are identifiable from the trust instrument, and certain provisions are present prohibiting the assignment or transfer of the beneficiaries’ interests, such a trust can act to shield inherited IRA funds from creditors, and the beneficiaries of the trust will be treated as the beneficiaries of the IRA. If the trust beneficiaries are treated as beneficiaries of the IRA, the trust may be able to stretch IRA distributions out over the oldest beneficiary’s life expectancy. Certain documentation must also be timely provided to the custodian or plan administrator. Such a trust can be designed as a fully discretionary trust, thereby providing the maximum protection from creditors.

The Supreme Court’s decision in Clark v. Rameker should provide a special impetus to planning for asset protection where significant estate wealth is concentrated in IRAs.

Disclaimer: This article is designed to provide information in regard to the subject matter and has been prepared with the understanding that neither the Illinois CPA Society nor the author of this article is providing accounting, tax or legal advice or is performing any legal, accounting or other professional service. If accounting, tax or legal advice or other expert assistance is required, the services of a competent professional person should be sought.

Key Highlight: Taxpayers should consider updating their will and/or trust documents to specifically authorize the executor/trustee to file a Form 706 to elect portability.

Section 2010 of the Internal Revenue Code of 1986 was amended in 2010 to allow the estates of decedents dying after December 31, 2010 an election to transfer the decedent's unused lifetime gift and estate exclusion amount to the surviving spouse (the portability election). The election is automatic if made on a timely filed Form 706 (including extensions). This election can be a great opportunity for estate tax savings for the surviving spouse when the surviving spouse's assets exceed the allowable exclusion amount ($5,340,000 in 2014). However, the executor/trustee of the first-to-die spouse may be reluctant to or be barred from incurring an expense of no benefit to the current estate. The following paragraphs discuss the benefits of portability and the situations where a special clause to elect portability may be beneficial.

To illustrate the benefit of portability consider a situation where a decedent dies in 2014. The basic exclusion amount is $5,340,000. If the decedent had previous taxable gifts of $500,000 (using part of the existing exclusion amount) and the remaining assets at death are $1,500,000, which are bequeathed to children, then the unused estate and gift tax exclusion amount for the first spouse's estate would be $3,340,000 ($5,340,000 - $2,000,000). If the portability election is made on a timely filed Form 706, the surviving spouse will have $8,680,000 as his or her estate and gift tax exclusion amount ($5,340,000 + $3,340,000) as opposed to $5,340,000. If the surviving spouse’s estate is large enough to use the full amount of the combined exclusion amounts, the estate will realize tax savings of $1,336,000. Clearly, in this situation, it would be advantageous to the surviving spouse if the estate of the first-to-die spouse files a Form 706, electing portability. However, since the filing of a 706 can be time-consuming and expensive, the residuary beneficiaries may be unwilling to delay the settlement of the estate and/or assume the expense of filing. They may even feel entitled to a share of the future tax savings that the surviving spouse is gaining by the filing of this return and election. Inclusion of a clause in the Will or Trust documents can avoid this conflict of interest.

Since the portability election is relatively new, most existing Will and Trust documents don't contain specific language granting the executor/trustee authority to make the election and incur the necessary expenses to do so. If the surviving spouse is both the primary beneficiary and executor of the estate there will be no conflict. In this circumstance, the surviving spouse just determines whether the value of the unused amount that is portable exceeds the expense of preparing and filing Form 706. However, in non-harmonious situations, the making of the portability election could become a source of dispute or litigation without any direction in the Will/Trust. This could easily occur in second marriage situations, where the children of the first marriage may feel no obligation to incur an expense to benefit the second wife.

It is therefore important that a provision exist in the Will/Trust that grants such authority and specifies who is responsible for the expenses incurred. If the surviving spouse is not a beneficiary of the estate and the executor chooses to prepare a Form 706 to elect portability without specific authorization, this could be interpreted as a breach of his fiduciary duties since he has incurred an expense of no benefit to the beneficiaries. This could lead to expensive litigation and loss of a valuable tax benefit to the surviving spouse. Alternatively, the document could authorize the preparation of the Form 706 but require the spouse to either pay the expenses directly or via reimbursement to the estate. Additionally, it may also be advisable to include a statement to the effect that the surviving spouse is entitled to all the tax benefit of the portable amount with no duty to share this benefit with the beneficiaries of the estate/trust.

Clearly, a provision in the Will or Trust document detailing the responsibilities of the parties with respect to the portability election may be effective in avoiding a contest and protecting the interests of all parties. Such a provision can give direction with respect to the filing of Form 706 and may provide that the surviving spouse pay the expense associated with such filing. In a second marriage situation, especially where a child of the first marriage is named as executor, such a clause will hopefully relieve tension between the surviving spouse and the children of the decedent. As always, in any review of estate planning documents, where there is both a Will and a Trust, you should confirm that the provisions addressing the payment of expenses and taxes are consistent with one another. Otherwise, confusion can result. You should consider adding a provision regarding the portability election to your checklist of required provisions for a Will and/or Trust.

Disclaimer: This article is designed to provide information in regard to the subject matter and has been prepared with the understanding that neither the Illinois CPA Society nor the author of this article is providing accounting, tax or legal advice or is performing any legal, accounting or other professional service. If accounting, tax or legal advice or other expert assistance is required, the services of a competent professional person should be sought.

The following represents a synopsis of T.C. Memo 2014-26 issued by the United States Tax Court (the "Court") on February 11, 2014. Numerous excerpts have been taken directly from the Court's document which readers are encouraged to examine for more details on this case.

At the time of her death, Helen Richmond (the "Decedent") owned a 23.44% interest in Pearson Holding Company ("PHC" or the "Company"), a family-owned personal holding company whose assets consisted primarily of publicly traded stock. The Decedent's estate tax return reported the fair market value of the interest in PHC as $3,149,767 supported by an unsigned draft report issued by a CPA with appraisal experience but no appraisal certifications. In his notice of deficiency, the Commissioner valued the decedent's interest at $9,223,658.

At trial, both the Commissioner and the estate submitted revised valuations with valuation conclusions of $7,330,000 and $5,046,500, respectively. Relying on a net asset value (NAV) approach, the United States Tax Court (the "Court") held that the value of the interest was $6,503,804 and assessed a 20% accuracy-related penalty under I.R.C. sec. 6662.

Background

PHC is a C corporation incorporated in Delaware in January 1928. As a holding company subject to tax on undistributed income (see sec. 541), PHC has a strong incentive to pay out most of the dividend income generated by the securities held in its portfolio. The stated objective of the company is to provide a steady stream of income to the descendants of Frederick Pearson while minimizing taxes and preserving/growing capital. PHC adhered to its stated objectives and, by the date of the Decedent's death on December 10, 2005 (the "DOD"), the portfolio of securities held by PHC had grown to $52.11 million, of which $45.6 million represented unrealized appreciation. If the total portfolio of securities had been sold on the DOD, PHC would have been liable for a corporate income tax liability of $18.1 million on this built in appreciation.

Prior to the DOD, the Company followed its stated philosophy of maximizing dividend income to shareholders while preserving capital. From 2000 to 2005 the Decedent's share of dividends ranged from $216,241 to $277,979 per year. From 1970 through 2005, dividend payments had grown slightly more than 5% per year. Also, in the ten years ending December 2005, the turnover of PHC's securities had occurred at an average rate of 1.4% per year. At this turnover rate it would have taken more than 70 years to experience a complete turnover of securities held by PHC.

From 1971 to 1993, there were nine transactions involving the sale or redemption of PHC stock by a shareholder and one shareholder death in 1999. In each case, it appears that the value of the stock was determined using a dividend model.

Since its founding, the ownership interests of PHC had become more diffuse and family relationships more distant. The Commissioner accepted testimony from an expert witness that, going forward, the owners would be increasingly likely to follow the financial advice of diversifying its holdings and estimated that a complete turnover of the portfolio would occur over the next 20-30 years.

Commissioner's Valuation

At Trial, the Commissioner's business valuation expert testified that the value of the Decedent's 23.44% interest in PHC was $7.33 million. This conclusion was reached using the cost approach. Starting with PHC's stipulated NAV of $52.11 million, the expert computed the Decedent's pro rata portion of PHC's NAV to be $12.21 million ($52.11 million x 23.44%). He then applied a discount for lack of control of 6% to arrive at a value of $11.48 million on a noncontrolling interest basis. A final discount of 36% was then applied (15% for BICG tax and 21% for lack of marketability) to arrive at a value of $7.35 million. Note: There appears to be a math error that the Court's record does not address. The expert reached a valuation conclusion of $7.33 million where the value calculated from the detailed formula presented in the record results in a value of $7.35 million.

Estate's Valuation

At trial, the estate introduced a new expert who testified that the value of the Decedent's 23.44% interest in PHC was $5,046,500. This expert relied primarily on the income approach using the capitalization-of-dividends method (a dividend growth model). The dividend growth model computed the present value of a normalized level of dividends for the Decedent's interest of $252,436 using a discount rate of 10.25% and a long-term growth rate of 5% per year. Note: it appears that, because this method utilized cash flows expected to accrue to a holder of the estate's interest in PHC, no further adjustments were required for BICG taxes (i.e., the cash flow stream would continue to be characterized as dividends regardless of the timing of capital gains taxes paid at the entity level), lack of control, or lack of marketability.

The estate's expert also proposed corrections to the Commissioner's cost approach, arriving at a value of $4.72 million for the Decedent's interest in PHC using the cost approach. Starting with the stipulated NAV of $52.11 million, the estate's expert subtracted $18.11 million for 100% of the estimated BICG tax at the DOD to arrive at an adjusted NAV of $34.00 million. He then applied a discount for lack of control of 8% to arrive at a value of $31.28 million on a noncontrolling interest basis. A final discount for lack of marketability of 35.6% was applied to arrive at an NAV of $20.14 million. The Decedent's interest was then computed at $4.72 million ($20.14 million x 23.44%).

Findings

The Court prepared its own valuation by applying the cost approach to arrive at a value of $6,503,804 for the Decedent's 23.44% interest in PHC. Starting with the stipulated NAV of $52,114,041, the Court subtracted 15%, or $7,817,106, to allow for BICG tax liability to arrive at an adjusted NAV of $44,296,935. The Decedent's 23.44% interest of $10,383,202 million ($44,296,935 x 23.44%) was then discounted by 7.75% for lack of control. The result was then discounted by 32.1% for lack of marketability to arrive at a value of $6,503,804.

Valuation Method

In a footnote to the discussion of the estate's primary valuation method, the Court indicated that the Commissioner did not dispute that the capitalization-of-dividends method can sometimes be used to value stock and did not dispute the dividend growth model equation used by the estate's expert. However, the Commissioner did dispute the appropriateness of using this method in this instance and the appropriateness of some of the values used. Later, in its opinion, the Court noted that slight changes to the assumptions used in the capitalization-of-dividends method produced results that were more than $1.0 million higher than that concluded by the estate's expert.

While acknowledging that the NAV method comes with its own difficulties and uncertainties (notably estimating the appropriate discount for lack of control and lack of marketability), the Court stated that it was overwhelmingly inclined to use the NAV method for holding companies whose assets are comprised of marketable securities.

BICG Taxes

In estimating the discount for BICG taxes, the Court acknowledged that opinions issued by the Courts of Appeals for the Fifth and Eleventh Circuits agreed with the estate's expert in deducting 100% of the BICG tax liability before considering lack of control and lack of marketability. However, the Court indicated that it, as well as other Courts of Appeals, had not followed this 100% discount approach. In its conclusion the Court dismissed the analysis used by the Commissioner's expert, but accepted as a concession, the 15% discount for BICG taxes used by the Commissioner's expert. In support of its conclusion, the Court considered the present value of the average annual capital gains computed over a 20-year period and a 30-year period (consistent with the testimony of a financial advisor who estimated that the portfolio would completely turn over in a 20 to 30 year period) using a discount rate of 7.0%. For example, the present value of $905,654.15 ($18,113,083 divided by 20) over 20 years using a 7.0% discount rate was computed as $9,594,513; and the present value of $603,769.43 ($18,113,083 divided by 30) over 30 years using a 7.0% discount rate was computed at $7,492,200. The Court noted that the 15% estimate for BICG taxes fell within the range of present values computed for these periods and accepted it as reasonable. Note: the Court did not provide support for its selection of a 7.0% discount rate and did not explain if the growth in the value of the underlying securities over the estimated 20 to 30-year timeframes was included in the calculation of built in gains (before discounting to their present value).

Accuracy-Related Penalty

In its assessment of the accuracy-related penalty, the Court indicated that a 20% penalty is imposed on any portion of an underpayment of tax required to be shown on a return where the underpayment is attributed to a substantial estate tax valuation understatement. The Court cited Section 6662(g)(1) that holds that a valuation understatement is substantial if the value of any property reported on an estate tax return is 65% of less of the correct value. Since the amount of the Decedent's interest in PHC reported on the estate tax return of $3,149,767 was less than 65% of the Court determined value of the of $6,503,804, the Court concluded that a substantial valuation understatement exists. Next, the Court considered whether an exception for any portion of the penalty could be made due to the taxpayer acting reasonably and in good faith. The Court noted that the taxpayer did not act diligently in relying on a draft report prepared by an accountant who was not a certified appraiser and which failed to adequately substantiate the methodology and assumptions used in the appraisal. Furthermore, the Court noted that the value reported on the estate tax return was less than 65% of the value used at trial and defended by the estate's own expert. Based on these and other factors, the Court concluded that the Commissioner met his burden to show that the accuracy-related penalty applies and the estate failed to show why it should be excused from the penalty. As a result, the Commissioner's imposition of an accuracy-related penalty under section 6662

Disclaimer: This article is designed to provide information in regard to the subject matter and has been prepared with the understanding that neither the Illinois CPA Society nor the author of this article is providing accounting, tax or legal advice or is performing any legal, accounting or other professional service. If accounting, tax or legal advice or other expert assistance is required, the services of a competent professional person should be sought.

Have you filed a Form 706, US Estate Tax Return after 7/31/15? If so, did you complete the new statement required to be filed with the service and each beneficiary within 30-days after filing? If you are starting to sweat, don’t worry too much yet. You now have until February 29, 2016 in order to complete and file this new statement under IRS Notice 2015-57. So instead of complying now, or within the 30-days after filing of an estate tax return, the due date is now 2/29/16 for these new statements. This doesn’t mean we don’t have to worry about preparing them as they are still required just delayed. With this deadline now being delayed, let’s discuss some of the requirements, and some possible issues that will require a supplemental statement. Hopefully, we will have a clearer understanding when the IRS issues some rules, or regulations.

President Obama recently signed into law the “Surface Transportation and Veterans Health Care Choice Improvement Act of 2015”, known as the Highway bill. This bill had many provisions that changed the due dates for various returns, and also the extensions. Although these are very interesting, what I want to focus on is the obscure new IRC Section 6035.

The IRS has long thought that the reporting of cost basis on inherited property was not consistent with what is reported on the estate tax returns, Form 706, and the amounts that the beneficiaries reported at the time of sale of the property. How does the Service get people to match this correctly, and report it correctly? Well this new IRC Section 6035 is an attempt to have some consistency. Although, I am very hesitant to think this is a good idea, I believe the cost of complying with the new requirement could greatly outweigh any revenue earned.

So let me summarize the law first and then raise questions that I will try to answer, given that the Service has given no guidance at this point.

For any federal estate tax return required to be filed, 30 days after the date on which the return was required to be filed (including extensions, if any), or 30 days of an adjustment to any information originally reported, the executor/trustee must provide a statement to the Service, and to ALL persons “who hold a legal or beneficial interest in the property to which such return relates”, a statement identifying the value of each interest in such property as reported on the estate tax return, and such other information with respect to such interest as IRS may prescribe.

By the way, the date of enactment is now! For ALL returns filed after 7/31/15, now extended until 2/29/2016.

All this sounds very simple since I was able to summarize in one long sentence. However, let’s discuss some questions and issues with Format, Questions to consider, What returns are included, Possible Adjustments and Penalties for failure to produce the statement.

Format of Statement:

A statement seems simple enough. What should be included in the statement?
What will we attach to the statement?
Will the IRS provide a form in the future?
Should we provide a separate form for each beneficiary?

Based on information the Service required on Form 8939, in 2010 when there was no estate tax and a carry-over basis, I suspect the Service will want a separate statement for each beneficiary. This will help with the privacy that should be required of the beneficiaries.

Obviously, the Service is going to try and match the statements to the cost basis reported by the beneficiaries on their income tax return, so they will require enough information to be able to do so. If we just provide copies of Form 706, Schedules A-I, then there is no privacy and no indication as to what asset each individual is receiving. Therefore, I believe the statement should definitely include the following:

Estate’s Name, Executor Name, address and decedent’s SSN to match the Form 706 data.
Beneficiaries’ name, address and SSN or EIN if a trust.
Listing of assets that each beneficiary should or could receive. In this case, I believe if it is the residue, then possibly copies of Form 706 schedules can be attached.

For stocks/bonds, include the number of shares in total and the cost per share.

I would break the statement into two parts:

Assets specifically devised, or that have a beneficiary designation, or jointly owned property, like personal property, home place, IRA, etc., and

Assets that will either relate to the residue or are calculated within the trust document, which calculation will not have been completed until final estate/trust distribution.

Be sure to provide disclaimers especially regarding personal property where the “realized loss” may not be deductible.

Until further clarification is provided, I believe the address to mail the statement should be the same address that you used to file the estate tax return.

Obviously, this information should be retained by either the beneficiary or the trust in a permanent file somewhere for ease of access.

Questions to consider:

Is the information that we provide relevant to each beneficiary?
What if the beneficiary is only a specific devisee and gets none of the residue?
What if some or all of the assets are sold prior to filing the estate tax return?
Why does the IRS believe that providing information that may be as much as 15 months old seems relevant?
What about items that don’t get a step-up in basis, like items of Income in Respect of Decedent (IRD)(i.e. IRA)?
Is there a lack of privacy with the attachments?
Do we know what assets will go to each individual?
Does giving this information lead a beneficiary to believe they are receiving all of these assets?
Should we get the beneficiary to sign off that they received the document?

As you can see there are many questions that I don’t believe we have all the answers at this point. I will try to give relevant information that may answer some of these questions. However, I don’t believe either the new IRC Code Section 6035 or the summaries so far written give us clues as to what is required to be done.

To make the answers relevant to each beneficiary, I believe advisors will need to account for the assets thoroughly until the estate tax return is filed. Have the assets been sold, or exchanged? If so, I believe we should report what they may be entitled to receive based on the document. Just attaching copies of Form 706 schedules could provide very unclear information to both the Service and the beneficiary. This would possibly make more change forms necessary in the long run.

As I mentioned, if we provide separate statements for each beneficiary, this should help with the issue of privacy and relevant information to all. If a beneficiary, whether an individual or a trust, is getting the residue, then a listing of all assets remaining can be included in the statement to each of the persons receiving a percentage of the residue. I do believe in the case of a residual beneficiary that a statement at the bottom should indicate that this is not a list of assets that each will receive at the end of the estate/trust administration, however, in accordance with Code Section 6035, we are providing the most up to date information to comply with this code section. During the period of administration, many changes can be made to this trust that could affect this information, and if such change is required to be reported by the Service, we will provide more information at that time to correct this information.

Assets that have no basis, like items of IRD, should be reported at zero to make sure no one is confused as to the basis. If all assets are sold, I believe a schedule showing the cash amount that each beneficiary is receiving and not a listing of assets owned at death. Since there is no indication as to what should be provided, a summary or more descriptive information can be given.

As for having the beneficiary sign-off, we could give the beneficiary and updated list of assets at the time of distribution and get them to sign off on the receipt and refunding agreement, although not required, that we should be sending at that point. Therefore, I don’t believe that a signature of the report filed within 30 days of the estate tax filing deadline would be required.

Should you file the tax return with all Federal Forms 706 filed with the service including if we are just filing to obtain portability of exemption between spouses?

Portability which came into the law in 2011 is allowed in IRC Section 2011(c). IRC Code Section 6035 states that “the executor of any estate required to file a return under section 6018 (a) or (b) shall furnish…” Unfortunately under IRC Section 6018(a), the IRS includes Section 2011(c) in paragraph 6018(a)(1). Although the words just indicate to use the basic exclusion in effect under this section, portability is included also in IRC Section 2010(c)(4) and (5). In order to make the election for portability, then one must file an estate tax return. Many commentators have concluded that the statement is not required in the case of electing portability. I think we will have to wait for further guidance to decide if it is required in the case of filing for portability. In the meantime, I believe we should file the statement with a return just filed for portability. If later issued regulations spell out that a statement should be filed, then the estate would be subject to penalty.

Why would we not file just to be safe from a conservative point of view? I suggest that we file this statement with all Federal Estate Tax Returns filed for any reason to be conservative in our approach. Why take a chance when the service will not know what to do with the statement anyway (No harm no foul).

If a Federal return is filed only for state purposes, then no statement needs to be filed with the secretary.

What Adjustments under IRC Section 6035(a)(3)(B) will require a supplemental statement to be filed?

This paragraph indicates that if an adjustment is made under either paragraph (1) or (2), after the statement is filed, then a supplemental statement is required to be filed within 30 days after the adjustment is made.

Many commentators have interpreted this to mean if a supplemental Form 706 is filed, or if changes are made through a court action or via audit adjustment, then a supplemental statement should be filed. This is a pretty basic approach, and we really don’t know what Section 6035 means by the word “adjustments”.

From my perspective I was wondering if other adjustments to basis while assets are held in an estate/trust would be included in the definition of “adjustments”.

Funding a pecuniary bequest that requires gain to be realized. The beneficiary would then have basis equal to fair market value at the time of funding, and not from date of death.

Same outcome will apply if the estate/trust elects to realize gains under Section 643(3).

What about basis in partnership/s-corp which requires yearly adjustments to basis based on the K-1 income, expense, capital contributions and distributions?

Passive activities that accumulate losses, as is the case with publicly traded partnerships. When these are distributed to a related party, then the basis is adjusted by the amount of losses that cannot be carried forward to the recipient.

Stock splits, or spin-offs that require a basis allocation different than as originally shown.

Rental, investment property additions during estate administration. (e.g. a new roof, or new furnace, etc.)

I’m sure there are other cases in which the cost basis will be different than what was reported on the estate tax return and included in the statement that we will be filing. I think it is obvious that the Service would like to be able to match the reporting of basis by the beneficiary, whether an individual or a trust with the statement that is filed reporting this cost basis. If that is the case, then I believe other adjustments will be necessary. If we don’t tell them how will the beneficiary know the starting point in which to continue to calculate their correct cost basis?

I don’t believe a supplemental statement should be provided if an asset is sold within the trust prior to distribution after the original statement was issued. This type of change would not be necessary, since the beneficiary will never have to report this sale on their tax return, especially if we put the proper disclaimers at the bottom.

Penalties for not filing the statement?

A new section defining definitions of statements now appears in Section 6724(d)(1)(D) of the code and under “Payee Statements”, IRC Section 6724(d)(2)(II) . Failure to file an information return under IRC Section 6721 or failure to furnish correct payee statements under IRC Section 6722 indicate that between 7/31/15 and 12/31/15, the penalty would be based on $100 per return not filed. After 12/31/15, that penalty goes up to $250 per return. Remember that we do believe that a separate return should be filed for each beneficiary, which if the estate/trust has 10 total beneficiaries, then that penalty could be assessed at $100 per return. Because of the newness of the situation and since no instruction has been given, one could ask for abatement of penalty.

The bill also included changes to IRC Section 1014, which speak about proper tax basis reporting for beneficiaries. This was included to make sure the individual does not claim more basis than that which is allowed by the step-up on the estate tax return. The penalty for an individual is related to inconsistent reporting under IRC Section 6662, which can be 20% of the additional tax due to the understatement.

As you can see from this analysis, there are MANY more questions than answers. However, we cannot delay filing the statements as that could subject your firm to risk, however, to find the proper formats and rules, we will need to wait until after we get more guidance from the IRS. Stay tuned!

Disclaimer: This article is designed to provide information in regard to the subject matter and has been prepared with the understanding that neither the Illinois CPA Society nor the author of this article is providing accounting, tax or legal advice or is performing any legal, accounting or other professional service. If accounting, tax or legal advice or other expert assistance is required, the services of a competent professional person should be sought.

Key Highlight: Various tax benefits will stay the same or change only slightly in 2016 due to inflation, the IRS announced.

The Internal Revenue Service recently announced the 2016 Inflation Adjustments in Revenue Procedure 2015-53. By law, the dollar amounts for a variety of tax provisions are required to be revised each year to keep up with inflation. The result of this is that certain tax benefits are subject to inflation adjustments each year. However, since recent inflation factors have been minimal, many of these benefits will stay the same or change only slightly for 2016. Key provisions affecting 2016 estate, gift, and trust returns, filed by most taxpayers in early 2017, include the following:

ADJUSTED - Estate and Trust Tax Rate Tables - for taxable years beginning in 2016 the 15% rate applies to income not over $2,550 and the maximum 39.6% rate applies to income over $12,400 with graduated rates in between.

ADJUSTED - Valuation of Qualified Real Property in Decedent's Gross Estate - for an estate of a decedent dying in calendar year 2016, if the executor elects to use the special use valuation method under § 2032A for qualified real property, the aggregate decrease in the value of qualified real property resulting from electing to use § 2032A for purposes of the estate tax cannot exceed $1,110,000. The 2015 amount was $1,100,000.

ADJUSTED - Unified Credit Against Estate Tax - for an estate of any decedent dying during calendar year 2016, the basic exclusion amount is $5,450,000 for determining the amount of the unified credit against estate tax under § 2010. The 2015 amount was $5,430,000.

UNADJUSTED – Annual gift exclusion - for calendar year 2016, the first $14,000 of gifts to any person (other than gifts of future interests in property) are not included in the total amount of taxable gifts under § 2503 made during that year.

ADJUSTED – Annual gift exclusion for gifts to a spouse who is not a US Citizen - for calendar year 2016, the first $148,000 of gifts to a spouse who is not a citizen of the United States (other than gifts of future interests in property) are not included in the total amount of taxable gifts under § 2503 and § 2523(i)(2) made during that year. The 2015 amount was $147,000.

ADJUSTED - Notice of Large Gifts Received from Foreign Persons - for taxable years beginning in 2016, recipients of gifts from certain foreign persons may be required to report these gifts under § 6039F if the aggregate value of gifts received in a taxable year exceeds $15,671. The 2015 amount was $15,601.

ADJUSTED - Interest on a Certain Portion of the Estate Tax Payable in Installments - for an estate of a decedent dying in calendar year 2016, the dollar amount used to determine the "2-percent portion" (for purposes of calculating interest under § 6601(j) of the estate tax extended as provided in § 6166) is $1,480,000. The 2015 amount was $1,470,000.

ADJUSTED - Net Investment Income Tax - for taxable years beginning in 2016, if a trust has undistributed Net Investment Income and also has adjusted gross income over $12,400 the investment income will be subject to the 3.8% Net Investment Income Tax. The 2015 adjusted gross income amount was $12,300.

Disclaimer: This article is designed to provide information in regard to the subject matter and has been prepared with the understanding that neither the Illinois CPA Society nor the author of this article is providing accounting, tax or legal advice or is performing any legal, accounting or other professional service. If accounting, tax or legal advice or other expert assistance is required, the services of a competent professional person should be sought.

For clients residing in certain jurisdictions such as Illinois and 13 other jurisdictions, where the amount exempt from state/local tax is currently less than the federal exemption, planning for the difference between the two is very important. States generally do not have the concept of portability that is now at the federal level (the ability of the first spouse to die and pass any unused federal exemption to the other spouse). The state exemption is a use it or lose it situation.

Consider an example of a couple with $5,000,000 in assets where both die, each a resident of Illinois, in 2015 (having made no lifetime gifts). There would be no federal estate tax on the first or second death. Assuming all the property of the first to die passes outright to the survivor (causing no state or federal estate tax to be payable at that time), on the second death (using the Illinois Attorney General’s 2015 tax calculator) the Illinois estate tax would be $285,714.

Two planning alternatives (based on the example) to reduce the survivor’s estate to $4,000,000 or below are the use of: (a) the credit shelter trust to shelter at least $1,000,000 of assets on the first death, or (b) a qualified disclaimer executed by the surviving spouse disclaiming $1,000,000 of assets, thereby reducing the survivor’s estate to under $4,000,000. The idea is to use up part of the state exempt amount at the first spouse’s death. By utilizing either (a) or (b), $285,714 of Illinois estate tax is saved as no state (or federal) tax would be payable.

For couples whose combined estates have assets under the federal exemption amount ($5,450,000 (2016)), but over the Illinois’ exempt amount ($4,000,000), consider using the typical marital trust and credit shelter trust plan for the first to die placing enough assets in a credit shelter trust with a formula modified to consider both federal and state death taxes. For couples with combined estates with assets over the federal exemption amount ($5,450,000 (2016)), consider a strategy of using two marital trusts and one credit shelter trust: (1) place enough assets in a credit shelter trust by a formula modified to consider state and federal death taxes, (2) use a formula to fund the difference between the exempt amounts (for Illinois, the $1,450,000 (2016)) into one marital trust that qualifies for state marital deduction (for which a state qtip election is made but no marital deduction taken for federal estate tax purposes), and (3) using the balance of the assets to fund the second marital trust which qualifies for both state and federal purposes. If only one marital trust is desired, consider using the portability election in the estate of the first to die to shelter the $1,450,000 from estate tax on the second spouse’s death.

Consider using funding formula(s) rather than specific dollar amounts in wills and trusts for flexibility to take into account (a) the indexing of the federal exemption amount; and (b) the state death tax exemption (consider New York’s changing exempt amount). As mentioned, a formula that takes into account both the federal and state exempt amounts ensures no tax is paid at the first death by funding the credit shelter trust with the amount that passes free of both federal and state estate taxes. State law may not have a means to ensure the state estate tax is paid on the second death if the spouse has moved out of state, so avoiding the state death tax on the first death and then moving the surviving spouse’s domicile out of the state (say to a state without an estate tax) may completely avoid the state level estate tax.

On the first to die, if no credit shelter trust was used, consider the use of a qualified disclaimer. This requires that the disclaimer under IRC Section 2518(b) be an irrevocable and unqualified refusal by the person to accept an interest in property. It must be: (1) in writing; (2) received by the transferor of the interest (i.e. such as a trustee) or his or her legal representative (usually the executor) not later than nine months after the date on which the transfer creating the interest is made (generally the date of death); (3) with the disclaiming person not having accepted the interest or any of its benefits; and (4) as a result of the refusal, the interest passes, without any direction by the disclaiming person, to either the spouse of the decedent or a person, including charity, other than the disclaiming person. Failure to have the disclaimer be a qualified disclaimer causes the disclaimer to be a taxable gift. Even if carefully planned for in advance, the burden of these requirements cause the use of a disclaimer to be considered a strategy of last resort or a fall back.

The current fourteen states/local jurisdictions with exempt amounts different from the federal exemption are Connecticut, District of Columbia, Illinois, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Oregon, Rhode Island, Tennessee (scheduled for repeal effective 1/1/16), Vermont and Washington. In planning, care needs to be taken to review the statutes of each particular jurisdiction the client resides (and/or holds real estate), as jurisdictions may or may not have indexed exempt amounts (i.e. Illinois), q-tip elections, the same exempt amounts, etc. Statutes also change over time (i.e. New York). With this in mind a review of a client’s estate plan whenever state/local tax law changes may be necessary.

Disclaimer: This article is designed to provide information in regard to the subject matter and has been prepared with the understanding that neither the Illinois CPA Society nor the author of this article is providing accounting, tax or legal advice or is performing any legal, accounting or other professional service. If accounting, tax or legal advice or other expert assistance is required, the services of a competent professional person should be sought.

Allowable expenses on the federal estate tax return are expenses that are “actually and necessarily incurred in the administration of the decedent’s estate; that is, in the collection of assets, payment of debts, and distribution of property to the persons entitled to it.” Reg. §20.2053-3(a). With regard to the deductibility of administration expenses incurred in the care of a pet after one’s death, it is in part based on whether the pet is a beneficiary or property and if property, whether the fact that the pet has little or no economic value determines whether expenses associated with the maintenance and care proper to distribution are deductible. If in fact, the pet were considered a beneficiary, any preliminary distributions made to that beneficiary cannot be deducted as administrative expenses. State law typically treats animals, including pets, as property.

Considering that there is very limited legal authority addressing the deduction of pet care expenses on the Form 706 under federal estate tax law, consideration should be given when drafting a client’s estate planning documents when care for a pet after death is desired. Provisions should be designed in order to position the estate to better sustain the deduction under the reasonable and necessary standard.

Some considerations:

The owner should specifically state what is to be done with the pet (i.e., the pet goes to an individual, the pet is provided for via a pet trust, lay out options if no one will take on the responsibility of the pet, etc.)

Pursuant to PLR 9119002, to better substantiate support for the deduction, an express provision should be included regarding the care for the pet and how funds will be available between death and distribution of the pet for its care.

The Will and/or Trust should specifically define the level of care for the pet.

After death, make distribution of the pet a priority in order to keep the associated expenses reasonable.

Although the economic value of the animal can play a role in the allowance of the deduction, it is believed that the substantial fair market value of the pet is not required under the law in order to support a reasonable administrative expense for pet care expenses under federal estate tax law.

So, while Pets are Not People, the changing legal environment regarding pets provides a basis as to their value and the deductibility of expenses on the Form 706 related to their care as property of the estate.

Disclaimer: This article is designed to provide information in regard to the subject matter and has been prepared with the understanding that neither the Illinois CPA Society nor the author of this article is providing accounting, tax or legal advice or is performing any legal, accounting or other professional service. If accounting, tax or legal advice or other expert assistance is required, the services of a competent professional person should be sought.

The holidays are here and the hustle and bustle of family gatherings and shopping is in the forefront of our mind. This is also a good time to review our finances and in particular, whether or not we need to take a required minimum distribution.

Even if you are still employed, you must take your first required minimum distribution (“RMD”) by April 1 of the year following the year in which you turn 70 ½. You can figure out what your RMD will be by looking at your account balance(s) as of the end of the year and dividing that amount by your life expectancy factor which is provided by the IRS. All future RMDs must be taken by December 31 of that year. If you have multiple IRA accounts, you can take your distribution from each or any of the accounts. You may be able to set-up an automatic RMD plan with your IRA custodian and the custodian will calculate your RMD and send you a check.

It is very important to take your RMD every year in order to avoid the 50% penalty based on the distribution not made or an insufficient amount taken. In the event there is an oversight and the RMD is not made or an insufficient amount taken, it is important to correct the mistake as soon as discovered and file the Form 5329 for each year missed with a detailed explanation as to why the oversight. Even though the penalty will be assessed, the taxpayer can request an abatement of the penalty which is most often granted.

The rules with regard to what happens with the RMD when an account owner dies can be quite complicated depending on if the IRA rolls to a spouse or other person. If a person other than a spouse is named as a beneficiary of an IRA, they will generally be required to take the RMD by December 31 of the year following the year of death. However, if the deceased owner did not properly take the RMD prior to death, then the designated beneficiary must take that amount prior to December 31 of the year of death.

This is also a good time to check your beneficiary designations. Leaving your IRA to charity at your death is a great planning tool in that it not only avoids the beneficiary’s share of the income tax, in the event you have a taxable estate, it also avoids the estate tax.

Disclaimer: This article is designed to provide information in regard to the subject matter and has been prepared with the understanding that neither the Illinois CPA Society nor the author of this article is providing accounting, tax or legal advice or is performing any legal, accounting or other professional service. If accounting, tax or legal advice or other expert assistance is required, the services of a competent professional person should be sought.